MICROCAPITAL STORY: How Far Will the Credit Crunch Affect the Microfinance Industry?

At the Worldwide Microfinance Forum, 1st-2nd October in Geneva, the investment managers and financial specialists of the industry met to discuss how they could improve their returns. The mood was upbeat, with a general agreement that this emerging sector has a growing and buoyant future ahead of it, despite the panic and events that were unfolding in the mainstream financial world as the conference took place.

Although the message on stage was business as usual, outside the conference hall there were discussions about what the final impact of the turmoil would have on the nascent industry. As Erik Geurts, Senior Investment Officer at Triple Jump said, “People here are a bit nervous, but don’t see it affecting them. But it will.”

Those taking the long view expressed two main concerns. First, that any kind of global difficulty could be extremely difficult for microfinance clients, the working poor, especially at time of rising inflation and food prices. As Mohammad Yunus said, “This (financial crisis) is not the only crisis for the poor – on top of this there is a food crisis. Recovering from this will be much more difficult and painful to watch.” Mr Geurts thought that inflation is the real criminal, saying, “this increases microfinance institutions’ (MFIs) operational costs, and these lead to an extra burden on their clients, especially hurting the poorest of the poor.”

Second, there was agreement that so far the industry had felt little impact, and that the real effect of the credit crunch would only be realised in the coming months. As Lauren Burnhill, Chief Investment Officer at Accion, said, “So far none of the portfolios in the [Accion] network have expressed a liquidity problem. Confidence is very high. We haven’t seen the impact yet and won’t for another three to six months.” Mary Ellen Iskenderian, President of Women’s World Banking agreed, “Money is still available, liquidity is still there, but I don’t want to speculate on the future.”

Damian von Stauffenberg, Founder and Principal of MicroRate, a specialised microfinance ratings agency, said, “In Latin America and Africa, where we rate MFIs, we have so far not felt the impact of the upheaval on financial markets. MFIs are so far doing fine. However I expect that if the US and/or Europe fall into recession, economies in developing countries should start to feel that pretty soon.”

But there was acknowledgement that MFIs could face difficulties as the cost of commercial borrowing rises, which could halt the rapid growth in the industry as they struggle to raise money and expand their client base. As Ms Iskenderian explained, “Money is still there, it’s just more expensive. Our network members are uneasy about raising interest rates. So there may be a slowing of growth in portfolios. Slow growth is not necessarily a bad thing – it was rampant before.” Ms Burnhill commented, “We told the MFIs to diversify their sources of funding [rather than relying on donor money] and the investment market has been an important source of funding. And that liquidity will dry up.”

This change will also impact investors. Sarah Forster, Director of Geoeconomics, a strategy consultancy focusing on sustainable development, who recently wrote a detailed report on Microfinance Investment Vehicles, commented, “Funds may find it more difficult to raise money.” She also thinks it could encourage both MIVs and MFIs to consider equity investments, as the cost of the scarce funds could make debt funding less popular.

Others were less pessimistic. Robert Annibale, Global Director of Microfinance for Citigroup thought that the notional amounts involved in the microfinance industry are so small compared to the overall finance industry that they are unlikely to be affected. “There are no dearth of funds in the industry and there is no liquidity issue.”

The main casualties in the MFI funding situation are the structured products that were being used to raise capital, such as Collaterised Debt Obligations and Collaterised Loan Obligations (CDOs/CLOs). As Ms Iskenderian explained, “the CDO structure was becoming a very nice and accepted way to get low cost funding for MFIs – that has now stopped. I don’t see it coming back any time soon.” In fact WWB had to drop plans for a CDO it was developing with Morgan Stanley for 14 of its members earlier this year, despite the fact that the recipients had shown good repayment rates, as has been the case with all the microfinance CDOs organised so far.

Mr Annibale agreed that CDOs will no longer exist, pointing out that the people and institutions working on them will no longer be available, as the whole financing technique has been discredited. He believes that other structures will have to provide the finance that CDOs were expected to bring, in particular domestic finance from local financial institutions in local currencies. His advice to MFIs is, “Fund yourself locally – it’s the most stable, natural funding source.”

MFIs could also be stung with more defaulting clients, due to rising interest rates and more difficult economic conditions. “Default rates may increase – this is a future risk,” said Mr Geurts. Such a development will undermine one of the industry’s most often quoted statistics, that microfinance has an unusually low risk of defaults. Mr von Stauffenberg thinks this belief is “absolute nonsense,” stating the reason that defaults have been so low up to now is because the industry has been small and growing, with a backdrop of benign economic conditions, which will no longer be the case after the crunch.

However, microfinance could come out of the financial crash looking rosy because of its counter-cyclical nature, the argument being that MFIs are less prone to suffer from international macroeconomic events than institutions in the developed world. As Ms Iskenderian commented, ”the uncorrelated risk is catching people’s eyes.” She added, “There is a body of research that supports the idea that this (MF) sector performs differently than the mainstream.”

However, others think that this is another microfinance shibboleth that will be exposed in the new world order. Mr von Stauffenberg explained, “Conventional wisdom has it that microfinance portfolios aren’t affected by economic downturns. That’s a nice sales pitch if you are selling microfinance funds to investors, but I suspect it will prove to be no longer true.” Ms Burnhill concurred with this view, “I’m not sure we’re going to look as counter-cyclical at the end of 2009. I hope so.”

All these developments indicate that life could get much harder for microfinance institutions, and that those who are not well set up to embrace the new financial challenges will suffer, especially those without adequate managerial and financial skills. The industry will come out leaner and more experienced, as Mr von Stauffenberg commented, “the coming slowdown will separate the wheat from the chaff.”

By Amy Rennison

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